Argentina braces for devaluation

December 26, 2001 Posted: 0137 GMT

BUENOS AIRES (Reuters) -- Argentina's interim government gave the first sign Wednesday that it was preparing to abandon a decade-old policy of keeping the peso valued at one U.S. dollar, and shopkeepers started raising prices to hedge against an almost certain devaluation.

Three days after Adolfo Rodriguez Saa was installed as president for three months after looting and riots forced out President Fernando de la Rua, the new finance chief said he was preparing an "orderly exit" from the practice of pegging the peso at one U.S. dollar -- which analysts doubt he'll manage.

Finance Secretary Rodolfo Frigeri said he was printing a third currency, to be used to pay state salaries, that would be allowed to depreciate against the dollar, perhaps eventually replacing the peso.

But as worry grew that the government could be overtaken by events, store owners fearing devaluation raised prices or canceled the huge discounts with which they had tried to drum up business. The recession has dragged on for four years and was the backdrop to violence last week prompted by government belt-tightening measures.

Banks and foreign exchange houses were shut for most business for the fifth day running and ATMs ran dry after a month of drastic curbs on cash withdrawals.

The Central Bank lifted the banking holiday for Thursday, but foreign exchange trade is to remain suspended. It also cut its minimum reserve requirement by 6 percentage points to help inject liquidity into the creaking banking system.

It was not clear whether the stock exchange, which suspended business amid the extended bank holiday, would resume trade Thursday.

One in five people in the work force is unemployed in Argentina, a South American nation of 36 million people. The average wage is $600 a month, but many prices are at European levels.

Despite a drop in Christmas shopping, with many people having no access to cash and savings stashed away in dollars, the local retailers' association said many shops had "hiked prices in pesos up to 20 percent in the last 72 hours given the uncertainty surrounding the exchange rate parity."

The debt suspension has hit even Japanese brokerage houses worried about a loss of revenues, although many economists say Argentina's widely expected default is not likely to cause the kind of emerging market crisis feared a few months ago.

"The aim is for there to be two Argentine currencies and the dollar," said Frigeri. He is due to announce details of economic plans Wednesday or Thursday.

The dollar peg brought Argentina inflation-free financial stability after being introduced in 1991 but it also made it one of the most expensive economies in the world for doing business. Many blame the peg for the stubborn recession.

Investors fear that the currency plans are just a quick fix, buying time for Latin America's third largest economy before a dramatic and sudden devaluation that would bankrupt thousands of firms indebted in dollars.

The president, a member of the Peronist Party, faces huge pressure to end growing unemployment and steep wage cuts that sparked the end of De la Rua, who quit after his economic austerity plans triggered looting and rioting that left 27 people dead.

"It's just buying time and trying to smooth over any sudden shock associated with moving away from the dollar peg," said James Malcolm, a currency strategist at JP Morgan Chase.

Calm has returned to the capital, where police battled with rioters outside the presidential palace and middle-class protesters took to the streets banging pots and pans.

But there was little Christmas spirit. Malls were half empty and some shopkeepers said sales were down by 50 percent from last year.

Rodriguez Saa is only in power until March, when Argentines will vote for a president to complete De la Rua's mandate ending in 2003. The Peronist Party is favored to win.

But his challenges include saving the banking system from collapse and deciding what to do with capital controls limiting cash withdrawals to $1,500 this month, imposed by De la Rua to avoid a run on banks.

The government said it would create of an emergency fund to help shore up local banks sapped by a run on deposits.

De la Rua's government was effectively cut off from foreign credit and provinces had to print a host of short-term bonds to inject liquidity into the system as tax revenues dropped.

The new currency -- the Argentino -- will be used to pay state salaries. But unlike the peso, it will not be backed by hard-currency reserves, leaving it vulnerable to devaluation.